RUSSIA: SUBNATIONAL GOVERNMENTS’
FISCAL RESPONSE
TO THE ECONOMIC DOWNTURN
RUSSIA: SUBNATIONAL GOVERNMENTS’
FISCAL RESPONSE
TO THE ECONOMIC DOWNTURN
December 15, 2016
Acknowledgements
This report, a product of the Macro and Fiscal Management Global Practice of the World Bank Group, was written
by a team led by Apurva Sanghi and Birgit Hansl (Lead Economists, World Bank). The team was comprised of
William Dillinger, Galina Kurlyandskaya, William Dillinger, Galina Kurlyandskaya and Daria Andreeva.
We are grateful to the following individuals and organizations for meeting with the team and providing valuable
information and insight: Mr. Vladimir Petrov (Deputy Chairman of the Federation Council Committee on Budget
and Financial Markets), staff of the Federal Ministry of Finance, and staff of the City of Moscow, Moscow
Oblast, the City of St. Petersburg, Leningrad Oblast, notably Gatchina Raion (Leningrad Oblast), and Vologda
Oblast. We would also like to appreciate Ms. Natalia Zubarevich (Lomonosov Moscow State University), Ms.
Karen Vartapetov and Ms. Ekaterina Ermolenko (Standard and Poor's Ratings Services), Mr. Alexander Puzanov
(General Director at the Institute for Urban Economics, Urban Institute), and Messrs. Leonid Limonov and Denis
Kadochnikov of the Leontief Center. The team would like to thank Stepan Titov, Ruslan Yemtsov, Aleksandra
Posarac, Olga Emelyanova, Tatyana Shadrunova, Tigran Shims, and Sevil Salakhutinova of the World Bank
Moscow Office for their guidance and support.
CONTENTS
1. Introduction . ................................................................................................................................................. 1
Structure and functions of subnational governments ........................................................................................... 1
Functions ......................................................................................................................................................... 2
Financing ............................................................................................................................................................... 5
Taxes . .............................................................................................................................................................. 5
Transfers . ........................................................................................................................................................ 9
Regional variations in per capita revenues...................................................................................................... 11
2. Fiscal performance . ..................................................................................................................................... 13
Debt . ............................................................................................................................................................... 15
3. The prognosis .................................................................................................................................................. 19
Short-term measures . ........................................................................................................................................... 19
Revenues ......................................................................................................................................................... 19
Expenditures . .................................................................................................................................................. 19
Long-term measures............................................................................................................................................... 20
LIST OF FIGURES
Figure B1: Subnational spending, percent of general government............................................................................ 2
Figure B2: Subnational spending, percent of GDP..................................................................................................... 2
Figure 1: Composition of subnational expenditures ............................................................................................... 2
Figure 2: Composition of subnational revenues...................................................................................................... 5
Figure B3: Sources of municipal revenues . ............................................................................................................... 12
Figure 3: Trends in subnational deficits................................................................................................................... 13
Figure 4: Trends in subnational revenues................................................................................................................ 13
Figure 5: Trends in subnational expenditures ......................................................................................................... 14
Figure 6: Subnational deficits .................................................................................................................................. 15
Figure 7: Trends in subnational debt ....................................................................................................................... 15
LIST OF TABLES
Table 1: Distribution of principal tax revenues among subnational tiers of government ...................................... 8
Table 2: Trends in composition of federal transfers................................................................................................ 10
Table 3: Variations in regional per capita revenues (thousands of rubles)............................................................. 11
LIST OF BOXES
Box 1: Russian federalism in the international context ....................................................................................... 2
Box 2: Functional assignments ............................................................................................................................ 3
Box 3: Sharing the corporate income tax............................................................................................................. 7
Box 4: Russia’s equalization transfer: Good practice?.......................................................................................... 9
Box 5: Municipal government revenues . ............................................................................................................ 12
Box 6: Non-contractual liabilities......................................................................................................................... 16
Box 7: Debt regulations ....................................................................................................................................... 17
Box 8: Functional reviews: a mixed track record ................................................................................................. 20
1 INTRODUCTION
The aim of this note is to present and analyze subnational fiscal trends in Russia in the context of overall slowing
economic growth and falling oil prices over the last few years. In particular, in 2015, GDP fell by 3.7 percent.
Despite efforts to cut expenditures, the federal deficit increased to 2.4 percent of GDP. Subnational governments
were also affected by the economic slowdown. Aggregate subnational revenues declined, in real terms, by 6
percent between 2014 and 2015. Revenues from taxes (including shares of federal taxes) fell by 4 percent while
federal transfers fell by 13 percent. Nevertheless, the aggregate fiscal performance of subnational governments
actually improved over this period. The nadir of subnational government finances occurred in 2013, when the
consolidated subnational deficit reached 0.9 percent of GDP. Since then, it has shrunk. In 2015, the deficit was
equal to only 0.2 percent of GDP. This was largely achieved by drastic cuts in spending. Spending in the social and
infrastructure sectors both fell by 9 percent in real terms between 2014 and 2015. This note examines the fiscal
prospects of subnational governments in Russia, focusing particularly on the nature of these spending cuts and
whether they are sustainable over the medium term.
STRUCTURE AND FUNCTIONS OF There are more than 2,000 first-tier municipalities
SUBNATIONAL GOVERNMENTS comprising more than 500 cities and more than 1,800
raions; and there are more than 20,000 second-tier
1. Russia has a complex structure of subnational
municipalities, comprising more than 1,600 townships
government. At the top level, the country is divided
and more than 18,000 rural communities.2
into over 80 federal subjects, termed oblasts and
federal cities. Territorial subdivisions also include krais
3. Under the current legislation, all municipalities
(administrative territories), republics, autonomous
(including rural settlements with small populations)
okrugs (territorial divisions), and autonomous oblasts.
are required to establish local governments, employ
The administrative units are grouped into eight federal
municipal office staff, formulate and execute budgets,
districts, each headed by a presidential plenipotentiary
appointed by, and representing, the President of the and conduct an independent debt policy. The law
Russian Federation, who monitors the performance assigns a set of expenditure responsibilities to each
of the regions in each federal district. Hereafter, all tier of municipal government (See Box 2). In practice,
these top-level geographical units will be referred to municipalities tend to be highly dependent on their
as “regions”.1 respective regional governments. They have limited
taxing powers and are largely dependent upon transfers
2. The territory of each regional government is in and shared taxes from their respective regions; as
turn divided into what might be termed “first-tier detailed below, the only major federally-designated
municipalities”. These consist of large cities (formerly source of revenue for municipal governments is a
known as cities of oblast subordination) and rural share of the personal income tax (PIT). As a result, the
raions (districts); the latter contain a variety of forms of municipalities tend to function as spending agents of
small towns and village governments, which this report their respective regions, rather than an independent
will refer to collectively as second-tier municipalities. tier of governments.
1
IMF Article IV Consultation, July 2010.
2
The federal cities are also divided into municipalities. Recent (2014)
legislation permits other large cities to do the same.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 1
BOX 1: Russian federalism in the international context
In aggregate terms, the degree of fiscal decentralization in Russia is similar to that of other large, middle-to-
high income federal countries. The first figure below shows the share of total general government expenditures
that are accounted for by subnational governments in Canada, the U.S., Australia, Russia, Brazil, and Germany.
As shown, Russia is not unusual. It is less decentralized by this measure than the U.S. or Canada but roughly
on par with the other three comparators. Another way to measure decentralization is to look at the size of
subnational government as a share of GDP. Again, Russian subnational governments are not as large as those
in Canada, but they are roughly on par with those in the U.S., Germany, and Brazil. Interestingly, the split in
Russia between spending at the regional level and at the local (municipal) level is also similar to that in the
U.S., Brazil, and Germany.
Figure B1: Subnational spending, percent of general Figure B2: Subnational spending, percent of GDP
government
30 80
70
25
60
20
50
15
40
10 30
20
5
10
0
Canada USA Brazil Germany Russia Australia 0
Province Local Canada USA Australia Brazil Russia Germany
Source: Federal Treasury of the RF. Source: Federal Treasury of the RF.
Note: data is based on IMF Government Finance Statistics (except US, where it also incorporates data on local finance from the US Census of State and Local Governments). Expenditures by central and
provincial government are net of transfer to subordinate levels of government. Provincial government are net of transfer to subordinate levels of government.
Functions 5. As shown in Figure 1, the social sectors—
4. The functions of each tier of subnational education, social protection and health—together
government are set out in federal legislation, account for just over half of total subnational
specifically Law 131/2003 as amended. Subnational expenditure. (Figure 1 shows the consolidated
functions are broad ranging. They include the provision expenditures of all three tiers of subnational
of social assistance, education (kindergartens and government, with transfers from oblasts to raions and
grades 1-11), and the operation of health care from raions to second-tier municipalities netted out).
facilities (although general hospitals are largely
Figure 1: Composition of subnational expenditures
funded by the regional divisions of the national health
2% 2% 1% 1%
insurance fund). In the infrastructure sectors, their 3%
responsibilities include regional and intra-city roads. 6% Education
26% Transport
Subnational governments are also responsible for Social protection
the provision of public utilities (e.g., district heating 9%
Health
and water supply) and public transportation. In total, Housing, utilities
subnational governments account for about one-third Administration
Culture
of total government expenditure.3 14% Sport
Debt service
3
In calculating this percentage, the total is calculated as the sum of
federal expenditures, regional and municipal expenditures, and Law enforcement
expenditures of federal extra-budgetary funds (the pension fund, 20% Other
social security fund, and the medical insurance fund together with
its regional divisions). Due to intergovernmental transfers between
16%
these entities, when estimating the shares of each entity, all
intergovernmental fiscal transfers are netted out. Thus, for example, Source: Federal Treasury of the RF.
subnational spending on hospitals, financed through the national
health insurance fund, are not included in ‘subnational expenditures’.
2 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
BOX 2: Functional assignments
The following functions are assigned to the three tiers of subnational government, respectively:
Regional:
• Providing health care in specialized hospitals (for tuberculosis, cancer, psychiatric conditions, and so on) •
Providing funds to municipalities for preschool, primary, secondary, and afterschool education • Providing
vocational education • Protecting the environment and nature reserves • Preventing disasters and emergencies
and dealing with their aftermath • Providing fire protection • Providing veterinary control and anti-epidemic
activities • Providing welfare services to senior citizens and persons with disabilities • Paying allowances to
families with children and to low-income households (for housing and utilities) • Supporting rehabilitated
persons subjected to repressions and workers in defense enterprises during World War II • Providing medical
insurance for the unemployed, children, and senior citizens • Running orphanages • Preventing terrorism •
Constructing and maintaining regional roads and other infrastructure • Providing intercity public transportation
• Maintaining regional public libraries and regional museums • Organizing cultural and sports events.
First-tier municipalities:
• Protecting the environment • Managing waste disposal • Maintaining raion libraries and museums •
Organizing recreational, cultural, and sports events in favor of all citizens of the raion• Providing electricity and
gas • Constructing and maintaining intersettlement roads • Providing intersettlement public transportation.
Second-tier municipalities:
• Delivering housing and utilities (electricity, heating, water, gas, streetlights) and providing waste collection
• Constructing and maintaining housing for low-income households • Providing basic fire protection •
Maintaining cemeteries • Maintaining parks and gardens • Maintaining settlement libraries • Organizing
recreational, cultural, and sports events in favor of the particular municipality’s citizens • Constructing and
maintaining intrasettlement roads • Providing intrasettlement public transportation.
6. Education is the largest single functional of the general revenues of regional governments,
category sector of subnational government although the federal government recently announced
expenditure. Spending in this sector accounted a $US50 billion financing program for new school
for 26 percent of total subnational expenditure in construction.
2015. Spending on general education (grades 1-11)
is financed out of the general revenues of regional 7. Health care accounts for 14 percent of
governments (as opposed to earmarked federal grants subnational expenditure. In principle, the burden
or municipal revenues). Funds to cover the recurrent of financing subnational health care facilities falls
costs of salaries and supplies are transferred through on the national health insurance fund (HIF), which
earmarked grants from the regional government to makes payments to territorial (regional) health funds,
first-tier municipalities (raions and cities of oblast which in turn transfer funds to individual health care
subordination) on the basis of formulas that largely institutions. Funding is allocated on a case basis—i.e.,
reflect enrollment. Individual schools are managed by according to the number of cases treated by each
first-tier local governments, which are also responsible institution, with levels of payment varying according
for paying for their utility costs. In 2015, responsibility to the nature of the case (there are reportedly more
for financing kindergartens was transferred from than 5,000 separate categories of treatments).
second-tier local governments to the regional The HIF is funded from two sources: (1) employee
governments, which now provide the necessary funds contributions (deducted at source), and (2) payments
to their respective municipalities. By and large, capital by regional governments on behalf of people who are
costs (new school construction) must be financed out not required to make contributions due to their status:
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 3
the young, the old, the disabled, and the registered Regional governments, at their discretion, can make
unemployed. The latter account for 50-70 percent of up the difference between the amount of the federal
regional government health expenditures (in Vologda, pension and the official ‘subsistence’ income, which
payments to the HIF account for Rb 5 billion of the 8 varies by region.
billion that the oblast spends on this sector).
10. Other forms of social assistance include utility
8. It is reported that payments from the HIF are subsidies and transport subsidies. In the case of public
largely sufficient to cover the recurrent costs of health utilities (district heating and water supply), these
care facilities (supplemented by official and unofficial subsidies take the form of individual reimbursements:
out-of-pocket payments by patients and their beneficiaries pay the normal tariffs to their respective
families). This was not always the case: The current utilities and then seek reimbursement from their
situation reflects federal decisions over the last four regional governments. In most cases, such subsidies
years to sharply increase the level of health insurance are means tested. For example, in Vologda Oblast
premiums. HIF payments are not, however, sufficient (as in most other regions), households are entitled
to cover the costs of new medical equipment or new to partial reimbursement for their district heating
facilities. Such costs must be financed out the general bills only if the bills exceed a certain percentage of
revenue of regional governments, although the federal household income. In the case of public transport,
government previously provided funding for hospital subsidies are provided in the form of discounted
renovations and purchases of medical equipment tickets to eligible groups, including honored citizens,
under a program that has now expired. Regional senior citizens, school children, and families with
governments are also responsible for financing the three or more children. Subnational governments also
operating costs of certain specialized hospitals out provide social assistance in the form of cash payments
of their own budgets. These include facilities for the to eligible groups. These include top-ups to the federal
treatment of tuberculosis, cancer, alcohol and drug childbirth grant and child allowances, as well as
addiction, AIDS, and mental illnesses.4 payments to ‘labor heroes’. Some of these are means
tested or capped, while others (including payments to
9. Social assistance accounts for 16 percent of labor heroes) are not.
total subnational expenditure. Spending in this sector
largely consists of payments or subsidies to specific 11. Transport (under the budgetary rubric of
categories of beneficiaries (rather than, for example, ‘national economy’) accounts for 20 percent of
the running costs of old age homes and orphanages). subnational expenditure. Much of this consists of
Some social assistance programs are mandated and spending on roads, which is financed from earmarked
financed by the federal government. Federal law, for regional road funds. Subnational governments are also
example, mandates specific benefits for veterans responsible for public transport, including the metros
of WWII and their surviving dependents. These are of Moscow and St. Petersburg. It is reported that tariffs
financed from the federal budget and transferred are generally high enough to cover the operating costs
through the regional budgets to final beneficiaries. of these systems (although as noted above, certain
But federal law also requires subnational groups of passengers receive discounted tickets at
governments to provide social assistance benefits to the expense of their subnational governments). The
other groups, without necessarily specifying the level costs of these subsidies are classified in subnational
of those benefits or providing any funding to pay budgets as social protection rather than as transport.
for them. One of the largest (i.e., costliest) benefits
(judging from evidence from the city of Moscow) 12. Housing and communal services: Russia’s
consists of top-ups to (federally financed) pensions. housing stock has largely been privatized. Owners
of flats in apartment blocks are required to either
4
The exclusion of these facilities from HIF financing is more a result join homeowners’ associations or make other
of history than of policy. Over time, the HIF has been expanding the
types of facilities it covers but it has not yet reached the specialized arrangements for the operation and maintenance of
hospitals.
4 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
building exteriors and common facilities, including 15. Taken together, these five sectors--education,
elevators. As a result, subnational government social protection, health, transport, and housing-
spending on the construction and maintenance -account for 85 percent of total subnational
of housing for the population at large is limited. expenditure (in 2015). As shown earlier in Figure 1, the
Spending in this sector instead consists of three major remainder is largely accounted for by administration
subcategories. (6 percent), culture (3 percent), and sports (2 percent).
Debt service, treated as a separate sector, accounts
13. The first subcategory is capital subsidies for only 1 percent of subnational expenditures.
to municipal utilities. In Russia, services such as
water supply, sewerage, and district heating are FINANCING
typically provided by municipal unitary enterprises 16. The general budgets of all three tiers of
(MUEs). These are owned by city governments and subnational government (regional, and first and
are subject to oversight by municipal departments second-tier municipal governments) are financed
for housing and communal services. In the main, from a combination of shared taxes, exclusive local
these enterprises raise sufficient revenues from taxes, non-tax own revenues, and intergovernmental
tariffs to cover their operating costs.5 (As noted transfers. All taxes are administered by the federal tax
earlier, subnational governments do provide indirect service with revenues returned in whole or in part to
subsidies to these enterprises in the form of subsidies the jurisdiction in which they were collected. Table
to certain groups, but these expenditures are 1 below lists the taxes assigned to each subnational
classified under social protection rather than housing tier, along with the share of each tax that each tier is
and communal services). However, tariff revenues are allowed to retain.
reportedly not sufficient to cover the costs of major
capital investments such as network extensions into Taxes
unserved areas and the replacement and upgrading
17. Shared taxes are the largest source of
of equipment (e.g., new boilers for district heating
subnational government revenue. Two of them—the
plants). These investments are instead financed from
personal income tax (PIT) and the corporate income
the general revenues of city governments, along with
tax (CIT)—account for over half (53 percent) of total
grants from the federal government.
subnational revenues (in 2015) (Figure 2).
14. The second subcategory consists of spending Figure 2: Composition of subnational revenues
on the construction of apartments for (or subsidies
4% 2% 1%
to) particular categories of citizens such as families 4%
CIT
23% PIT
with children and teachers in rural areas, along with 7% Excise
fuel subsidies to low-income households and grants
Property taxes
to municipalities for similar purposes. The third 8% Other taxes
subcategory consists of spending on ‘beautification’ Non tax revenues
(e.g., maintenance of parks and gardens). Together, Unconditional grants
8%
these three subsectors accounted for 35 percent, Matching grants
32 percent, and 25 percent of total spending in the Compensation grants
30%
sector, respectively. ‘Other issues’ accounted for the 8% Other transfers
remainder of spending. 5% Other revenues
Source: Federal Treasury of the RF.
5
This has not always been the case; In the 1990s, tariffs were set far
below levels sufficient to cover operating costs, but since 1997, the
federal government has set national norms for the percentage of total
costs of communal services to be recovered from household bills.
According to the World Bank’s 2006 infrastructure report, the norm
was gradually raised from 35 percent in 1997 to 100 percent in 2005.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 5
18. Personal Income Tax (PIT): The PIT is the largest 20. Regional governments are allowed to adjust the
single source of subnational revenue, accounting for rate of the CIT within a range of 13.5 to 18 percent8
30 percent of the total in 2015. PIT revenues are the (they have no control over the rate of the PIT). Tax
exclusive purview of subnational governments—the reductions can be targeted at specific firms. Vologda
federal government retains none of it. Proceeds of the Oblast, for example, recently provided a five-year
PIT are divided among the regional and subregional reduction in the CIT rate (to the minimum 13.5
(first and second-tier) municipalities on the basis percent) to a new fertilizer plant.
of percentages. At present, regional governments
retain 85 percent of the personal income taxes 21. Property taxes: Another eight percent of
(PIT) collected in their jurisdictions. Cities (of oblast subnational revenues are derived from various forms
subordination) retain the remaining 15 percent (See of property tax. By far the largest form of property
Table 1). In areas of raion jurisdiction, PIT revenues are tax, accounting for 77 percent of the total in 2015,
divided between the raion government and second- is the corporate asset tax (Налог на имущество
tier municipalities. In urban settlements, raions retain организаций). This is imposed on movable and
5 percent of PIT generated in those jurisdictions, with immovable property owned by registered companies.
the settlement retaining the remaining 10 percent. In Methods of assessment are currently under reform.
rural settlements, raions retain 13 percent, with the Previously, the tax was assessed on the basis of
settlement retaining only 2 percent.6 book value. With the encouragement of the federal
government, regions are now gradually introducing
19. Corporate Income Tax (CIT): The CIT accounts ‘cadastral’ (market) values for particular groups of
for 23 percent of total subnational revenues. At taxpayers. St. Petersburg and Vologda Oblast claim
present, regional governments retain 90 percent of that they are now valuing certain categories of
the CIT, with the federal government retaining the corporate property according to its ‘cadastral’ value.
remainder. 7(Prior to 2009, the regional governments’ (In Vologda, it is only office and commercial space
share had been 73 percent.) Until recently, proceeds of that is valued at market rates, not factories.) The most
the CIT were retained in the jurisdiction in which they recent Russia-wide cadastral valuation was performed
were collected. As a consequence, a disproportionate in 2012 and used a complex (50 variable) form of mass
share of the CIT was retained by the City of Moscow, appraisal. The next cadastral valuation is scheduled
where corporate headquarters tended to be located. for 2018.9 Regional governments have the authority to
At present, corporate income taxes paid by vertically set the rate of the corporate asset tax within a range
integrated companies with operations in more than fixed by federal legislation. In Vologda, the rate is 2.2
one region are distributed among the regions where percent (if assessed at book value) and 2 percent (if
the company does business according to the value of assessed on the basis of cadastral value). Small firms
the company’s assets and employees’ salaries in each were formerly exempt, but are now subject to a rate
region. This has resulted in a reduction in Moscow’s share of 0.5 percent.
of the CIT and a corresponding increase in the shares of
other regional governments. Even so, CIT revenues are
still concentrated in Moscow. With 8 percent of Russia’s
population, the City of Moscow accounts for 24 percent
of total subnational CIT revenues.
6
The percentage of the PIT retained at the regional level has varied
over the years. Prior to 2009, the tax was imposed at a rate of 24
percent, with the regions retaining 73 percent of the proceeds
and the federal government retaining the remainder. In 2009, the
aggregate tax rate was dropped to 20 percent and the regional
share was increased (slightly) to 75 percent. As shown in Table 1,
8
In 2017 – 2020, the range will be 12.5 to 17 percent.
the regional share is now 85 percent, with first-tier and second-tier
9
The cadastral evaluation is performed by independent companies
municipalities retaining the remainder. authorized by the federal government, and the methodology is
7
In 2017 - 2020, regional governments will retain 85 percent of CIT, unified across the country. The regions can only check if the data on
with federal government retaining the remainder. the entry is correct.
6 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
BOX 3: Sharing the corporate income tax
Russia is unusual in sharing such a large proportion of CIT with subnational governments—and sharing it on
the basis of origin. Most countries in the region only share the PIT. While some (such as Germany) share the
VAT, sharing is not on the basis of origin, but rather on the basis of population and other factors.
The most obvious argument against sharing the CIT on the basis of origin is that CIT revenues tend to be
concentrated in a few large cities where most companies are registered. As a result, the CIT does not provide
much revenue to other places. But there is a more fundamental drawback: As a general principle, the taxpayers
of one jurisdiction should not be allowed to impose the costs of the services they consume on taxpayers who
live elsewhere. CIT sharing allows them to do so. Although CIT revenues are collected from companies, the
ultimate burden of the tax is shifted—backward onto stockholders or labor, or forward onto consumers. There
is no reason to believe that these stockholders, workers, or consumers are located in the jurisdiction where
the company is registered. As a result, sharing the CIT on the basis of origin allows the residents of places
where companies tend to be registered (e.g., Moscow and St. Petersburg) to extract implicit subsidies from
residents of other jurisdictions. The current arrangement, in which CIT revenues are partly distributed on the
basis of the location of company assets and labor, goes some way to addressing this, but not entirely.
One solution to this problem would be to entirely abolish CIT sharing on the basis of origin. Instead, the
subnational share of CIT revenues could be folded into the pool of resources used to finance the equalization
transfer. In this way, the equalization transfer would aim to reduce per capita disparities only in the PIT.
22. There are two other forms of property of maximum rate of residential properties is extremely
exemptions and rate reductions for certain classes low: 0.1 percent.11Federal law also permits a long list
taxation. The first is on land. This tax is imposed on of exemptions and rate reductions for certain classes
both urban and rural plots of land (except forests). of taxpayers (e.g., pensioners and veterans) and types
Since 2014, land has been valued on the basis of its of property. As a result, the building tax accounts for
cadastral value. Proceeds are retained at the municipal only 3 percent of property tax revenues and only 0.3
level, and municipal governments (including the percent of total subnational revenues.
cities of Moscow, St. Petersburg, and Sevastopol) are
permitted to set the rate of the tax, subject to a ceiling 24. Then there are the subnational shares of
of 0.3 percent on agricultural and residential property certain excise taxes—on alcohol and gasoline. Taken
and 1.5 percent for land in other uses. The land tax together (with other excises), these account for 5
accounts for 20 percent of property tax revenues, percent of total subnational revenues. As shown in
although only 2 percent of total subnational revenues. Table 1, revenues from the excise on alcohol is divided
50:50 between the federal and regional governments,
23. The second is a tax on buildings. This is imposed with the regional share allocated on the basis of origin.
on residential and commercial property owned Eighty-eight percent of the excise tax on gasoline
by individuals (as opposed to corporations). Since is retained by regional governments. Gasoline tax
2014, the tax has been assessed on the basis of revenues are distributed among regions on the
cadastral values10 and is retained at the municipal basis of road mileage, and regional governments are
level. Municipal governments are permitted to set obliged to share 10 percent of the tax with municipal
the rate of the tax, subject to federal ceilings. The governments on this basis of road mileage.
10 How accurate and up-to-date these cadastral values are is subject
to some dispute. The valuations in Vologda Oblast were reportedly
based on norms developed in the 1970s and 1980s, which have been
periodically adjusted to reflect inflation. St. Petersburg and Vologda This ceiling applies to residential properties that are assessed on
11
are both contemplating improvements in their methodology for the basis of cadastral values. The maximum rate for residential
valuing building for tax purposes. Both jurisdictions also note that properties valued on the basis of book value is 0.3 percent. Note
there has not been an inventory of taxable properties for several that the maximum rate for office buildings and shopping centers is
years (since 2013, in the case of Vologda). As a result, recently considerably higher: 2 percent. All other properties are subject to a
constructed buildings are not being taxed at all. maximum ceiling of 0.5 percent.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 7
Table 1: Distribution of principal tax revenues among subnational tiers of government
Percent share retained by each tier as of 2016*
First tier
municipalities
Second tier
Federal Regional Cities Raions municipalities
Corporate income tax 10 90
Personal income tax 85 15 5 or 13c 10/2d
Corporate property (asset) tax 100
Individual property and land taxes 100 10
Vehicle tax 100
Gambling taxb 100
Retail trade taxc
Excise on alcohol 50 50
Excise on hard liquors 60 40
Excise on low-alcohol drinks 100
Excise on gasolined 12 88
Excise on fuel for domestic furnaces 100
Reservoir use tax 20 80
Simplified tax on imputed income 100 100
Simplified tax on small businesses 100
Single agriculture tax 100 50 or 70e 30
Mineral Resource Extraction Taxes
-Tax on extraction of common minerals and diamonds 100
-Tax on extraction of other minerals excluding hydrocarbons f
40 60
Notes:
a. Urban second-tier municipalities retain ten percent of the PIT; rural second tier municipalities retain two percent. Raions retain the remainder of the 15 percent share assigned
to municipalities in total..
b. Where permitted
c. Only in federal cities
d. Gasoline tax revenues are distributed among regions on the basis of road mileage, not origin.
e. Urban second-tier municipalities retain 50 percent; rural second tier municipalities retain 30 percent. Raions retain the remainder
e. 100% of taxes on extraction of hydrocarbons are retained by the Federal Government
25. Subnational governments also generate income of common minerals and the tax on ‘other minerals
from a variety of other taxes. Together, these account excluding hydrocarbons’. The former is fully retained
for about 8 percent of subnational revenues. The by the regions, while the revenues from the latter
most important of these (accounting for one-third of are shared between the regions (60 percent) and
the total) is the transport tax. This is an annual tax on the federal government (the remainder). These taxes
vehicle ownership, based on the power of the vehicle. are not major revenue sources from an aggregate
Subnational governments also retain the proceeds of standpoint but are important in certain regions such
taxes on small-scale economic activity: the simplified as Sakha-Yakutia, a diamond-producing region. In
tax on small businesses (which is currently entirely addition, the three federal cities are permitted to
retained at the regional level), the simplified tax on impose a tax on retail trade. To date, the tax has only
imputed income (entirely retained by the first-tier been imposed in Moscow.
municipalities), and the single agricultural tax, which is
divided among first-tier and second-tier municipalities 27. Non-tax own-source revenues are non-trivial.
as shown in Table 1. (This list of excise taxes is not As shown in Figure 2 above, they account for about
exhaustive). 8 percent of total revenues. According to the budget
code, non-tax revenues include revenues from the
26. Regions are also entitled to revenues from sale or lease of property owned by subnational
certain mineral resource extraction taxes, namely governments (including property owned by their
the tax on the extraction the tax on the extraction enterprises), revenues from services rendered by
8 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
BOX 4: Russia’s equalization transfer: Good practice?
In most respects, Russia’s current equalization transfer represents good practice. It has a logical target (bringing
the per capita discretionary revenues of all regions up to a uniform percentage of the national average) and is
based on objective, readily measurable variables. The general design of the formula for determining the level
and distribution of the transfer is fixed in law and is therefore stable and relatively invulnerable to short term
political pressures.
The system does, however, have its critics. Some would argue that it is too complex, given the variety of
adjustment factors and the two-stage process for calculating the amount due to each region. Others would
say that it places too much of the risk of economic fluctuations on the federal government (as noted in the
main text, the transfer represents an open-ended commitment by the federal government to bring the per
capita revenues of each regional government up to the target level, regardless of the amount required). Some
would say it is insufficiently equalizing, noting the wide variation in per capita revenues that remains even
after the transfer is distributed.
But these characteristics represent policy choices; tradeoffs between equally desirable objectives. The
complexity of the transfer formula represents an effort to reflect variations in the unit costs of services among
regions. The open-ended nature of the federal commitment reduces regional governments’ vulnerability to
economic turbulence. The existing degree of equalization also represents a tradeoff. On one hand, it can be
argued that regional taxpayers should be the ones who benefit from the taxes they pay; e.g., that the taxes
paid by the people of Moscow should remain with the Moscow City Government. On the other hand, it can
be argued that many of the services provided by subnational governments have implications that extend far
beyond the boundaries of a single jurisdiction. One would not want the quality of education in a poor and
remote region to depend solely on the strength of its tax base. In evaluating a transfer system, the relevant
question is whether it strikes the right balance between these competing objectives.
budget-financed institutions, and fines and fees. government—is an equalization grant. This grant is
Interviews with Moscow City and Vologda Oblast designed to raise the per capita budget revenues of
suggest that the majority of revenues under this rubric poorer regions (those with per capita revenues below
are derived from the rent or sale of property owned the national average) up to a target percentage of
by the respective jurisdictions. the national average. In calculating the equalization
target, the 10 richest and 10 poorest regions are
Transfers excluded. Adjustments are also made to reflect
28. Transfers from the federal government (i.e., variations in the strength of tax bases among different
money distributed to regional governments on a regions, as well as differences in factors that affect
basis other than origin) accounted for 17 percent of the costs of providing services (for example, labor
regional revenues in 2015. The Russian budget code costs, living costs, and population density). The total
distinguishes three types of transfers: dotacii, subsidii, amount of the transfer is determined endogenously;
and subventsii. i.e., the federal government is required to contribute
whatever sum is needed to achieve the equalization
29. Dotacii: Transfers that are not earmarked— target. Roughly three-quarters of the regions receive
i.e., those that can be spent at the discretion of the equalization grants.12
recipient—are referred to as dotacii. As shown in Table
2, dotacii account for 40 percent of total transfers.
Starting in 2016, the transfer allocation rules guarantee that regions
12
The largest dotacii—and the largest single transfer whose revenues from the equalization transfer are at least 10 percent
greater than their other revenues shall receive no less than 90% of
from the federal government to the regional tier of the previous year’ amount.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 9
30. In 2015, equalization grants accounted for about were adversely affected by the economic crisis
75 percent of total dotacii. Of the remainder, about (although the revenue declines were not the direct
20 percent consisted of federal transfers to support result of federal policies). More recently, the federal
increases in the salaries of teachers, doctors, and government provided partial compensation to certain
certain other categories of subnational employees.13 jurisdictions for revenue losses arising from the
The salary increases were instigated by a presidential change in the methodology for distributing revenues
directive advising14 regional governments to raise the from the CIT (see above).
average wages of subnational teachers, doctors, and
certain other employees to the average prevailing wage 32. Subsidii are federal matching grants. These
in their respective regions. The directive was issued in support a wide range of federal programs, some— but
2012, with increases to be phased in over 2013-18. not all—of which involve capital investments. There
As originally envisioned, the federal government was are reportedly dozens of such programs, many with
to pay one-third of the cost of the increase during their own subprograms. (For example, the cattle
the transition period, with subnational governments program has a subprogram for dairy cows and another
financing the remainder on their own. Officials in a for beef cattle.) The typical matching arrangement is
small number of oblasts and cities interviewed for this 14 percent federal/30 percent regional, although this
report claim that the targets for specific categories varies. According to interviews in Vologda Oblast,
of employees in their respective jurisdictions have the procedure for applying for these grants and the
been achieved. However, recently, the target has been conditions attached to them are so arduous that
adjusted downward, by excluding certain higher paid many regional governments do not even make the
occupations (e.g., police) and including others (e.g., attempt—or at least are very selective in making
small businesses) from the calculation of the prevailing such attempts.
regional wage.
33. Subventsii: The third major category of
31. Other dotacii include grants to cities under transfers consists of compensation for functions
special regimes: cosmodromes and cities built around that subnational governments perform on
scientific centers and defense industries. The federal behalf of the federal government. These include
government also makes ‘adjustment grants’ under unemployment subsidies, rent subsidies granted to
this heading. First introduced in 2004, these grants certain categories of federal beneficiaries, such as
compensate regions for short-term reductions in tax war veterans or victims of radiation catastrophes,
revenues or increased expenditure burdens that result benefits paid to blood donors, and the costs of
from federal policies. In 2009, the federal government running civil registration offices.
used this instrument to assist regions whose revenues
Table 2: Trends in composition of federal transfers
Transfers 2009 2010 2011 2012 2013 2014 2015
General grants (dotacii) 39 37 34 32 40 46 40
o/w
Equalization grants 25 28 24 24 28 26 30
Capital grants (subsidii) 36 30 31 35 34 25 25
Grants for federal mandates (subventsii) 19 27 20 18 18 19 21
Other transfers 6 6 14 15 7 10 14
Source: Federal Treasury of the RF.
13
Although these transfers were intended to achieve a specific purpose,
they are nevertheless classified as dotacii (unearmarked).
14
Although subnational governments have the legal authority to set the
wages of their employees, federal directives have a strong influence
on these decisions.
10 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
Regional variations in per capita revenues several cases, it also reflects unusually high revenues from
34. These aggregate figures for Russia as a whole equalization transfers (dotatsii) presumably because the
conceal substantial variations across regions— equalization formula recognizes the unusually high costs
both in terms of levels of aggregate revenues (per of providing services in these regions.
capita) and composition. The table below illustrates
the variations in per capita revenues among regions. 36. The second ‘group’ consists of the cities of
(Note that the table does not include all regions.) Moscow and St. Petersburg, with per capita revenues
The figure for each region includes the own source of Rb 137,000 and 86,000, respectively. These (again)
revenues of subordinate jurisdictions. Thus, the figure derive unusually high revenues from own source
represents the consolidated per capita revenues of revenues, including the corporate and personal
all subnational governments in that region, from the income taxes. Neither derives significant revenues
regional government itself to the smallest second-tier from federal transfers.
municipality. Revenues are expressed in thousands
of rubles per capita and include both own source 37. The third group consists of all the other regions,
revenues and transfers from the federal government. where per capita revenues range from Rb 30,000
(Dagestan) to RB 87, 000 (Murmansk). As a group,
35. In essence, the regions fall into three groups. these regions derive about 75 percent of their income
The first group consists of the eight (generally) sparsely from own-source revenues—the corporate income
populated oil/gas/gold producing regions located in tax, personal income tax, and other taxes and non-
the far North and East (Siberia) of the country. These tax revenues. Only about 10 percent is derived from
are the richest regions in per capita terms, with per equalization transfers.15 As a result, variations among
capita revenues ranging from Rb 150,000 to 555,000. individual jurisdictions largely reflect variations in
This is due, in part, to unusually high levels of revenues their respective tax bases. The correlation between
(per capita) from own source revenues—including the per capita own-source revenues and total revenue
corporate income tax and the personal income tax. In per capita is 0.68. Equalization transfers do have some
Table 3: Variations in regional per capita revenues (thousands of rubles)
Rich natural resource based regions
88 - Chukotka Autonomous Okrug 555 90 – Yamalo-Nenets Autonomous Okrug 255
61 – Sakhalin oblast 457 38 – Kamchatka Krai 205
84 - Nenets Autonomous Okrug 426
Moscow, Saint Petersburg
73 - Moscow 137 St. Petersburg 86
All others
77 – Altai Republic 79 28 - Vladimir oblast 41
07 – Komi Republic 78 27 – Bryansk oblast 40
19 – Krasnoyarsk Krai 74 63 – Smolensk oblast 40
48 - Moscow oblast 73 52 – Omsk oblast 40
22 – Khabarovsk Krai 68 55 – Penza oblast 36
23 – Amur oblast 64 15 – Chuvash Republic 36
11 – Tatarstan Republic 63 10 - Republic of North Ossetia-Alania 35
78 - Jewish Autonomous Oblast 61 33 – Ivanovo oblast 35
34 – Irkutsk Oblast 53 60 – Saratov oblast 35
80 - Republic of Khakassia 53 04 – Republic of Kabardino-Balkaria 34
14 – Republic of Ingushetia 53 21 – Stavropol Krai 33
57 – Pskov Oblast 41 03 – Republic of Dagestan 30
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 11
impact in offsetting variations in per capita own source regions in the south and west of Russia tend to have
revenues. Revenues from equalization transfers are higher per capita revenues than those in the north and
negatively correlated with own- source revenues east. But with few exceptions (such as the Chechen
(r=-.55). But the scale of equalization transfers is too Republic), this is again largely due to variations in
small to offset variations in own-source revenues. The regional tax bases.
BOX 5: MUNICIPAL GOVERNMENT REVENUES
Regional governments have considerable discretion over the financing of their municipalities, subject to
general guidelines in the Budget Code. The Code authorizes regional governments to use two instruments to
provide general budget support (as opposed to earmarked funding for functions such as education) to their
municipalities.
First, they may assign a fixed percentage of their own taxes (including their shares of the personal income taxes)
to their subordinate jurisdictions. As noted earlier, municipalities are legally entitled to 15 percent of the PIT
revenues collected in their jurisdictions. (In the case of jurisdictions with two tiers of municipal government,
the upper-tier’s share is 5 percent of the PIT in urban jurisdictions and 13 percent in rural jurisdictions.)
However, regional governments may increase these percentages on their own cost, provided the shares are
uniform for all municipalities and are distributed on the basis of origin.
Second, they may establish formula-based Figure B3: Sources of municipal revenues
equalization transfers. The Code envisions that
5%
these will be allocated on the basis of tax capacity
18%
and cost drivers (for example, the socioeconomic 0%
status and age profile of the population, climate, PIT
and so forth). It also allows for ‘negative transfers.’ Other shared taxes
If a municipality’s per capita revenues are more 13% Own revenues
than twice the average for the region, the regional Transfers
Other
government is permitted to take up to 50 percent of
64%
the excess and reallocate it to poorer jurisdictions.
In their intergovernmental fiscal relations with
municipal governments, regions may also combine
Source: Roskazna.
shared taxing mechanisms and transfers.
As shown in the figure above (Figure B3), shared taxes (consisting almost entirely of the PIT) constituted 18
percent of municipal revenues in 2015. Transfers (including equalization transfers and earmarked transfers)
constituted 64 percent. As noted earlier, municipalities are also entitled to 100 percent of the revenue from
the simplified tax on imputed income, the building tax, the land tax, and the single agricultural tax revenues
(municipalities do not administer these taxes but are allowed to set their rates). Together with various non-tax
revenues, these account for 13 percent of municipal revenues.
12 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
2 FISCAL PERFORMANCE
and only subventsii (and the modest category ‘other
38. At an aggregate level, subnational governments transfers’) increased. In aggregate, federal transfers
seem to be weathering the current slowdown in
the economy fairly well. Figure 3 shows the overall Figure 4: Trends in subnational revenues
3,500
balance of consolidated subnational governments
as a percent of GDP since 2004. As shown, the 3,000 CIT
Constant Rub billions of 2015
PIT
aggregate subnational balance reached its nadir in 2,500 Excises
2013 (at 0.9 percent of GDP), just as the slowdown Property taxes
2,000 Other taxes
in the economy as a whole was beginning (Russia’s Non-tax revenues
GDP was still growing in 2013, albeit at an anemic 1,500 Unconditional grants
Matching grants
1.3 percent). In 2014, the GDP growth rate shrank to 1,000 Compensation grants
0.7 percent. As noted earlier, the economy shrank by 500
Other transfers
Other revenues
3.7 percent in 2015, but the aggregate subnational
0
balance improved over this period, with the deficit 2012 2013 2014 2015
declining from 0.6 percent of GDP in 2014 to just 0.2 Source: Roskazna.
percent of GDP in 2015. As a percent of revenues,
the consolidated subnational deficit declined from 8 declined by 10 percent over the period.15
40. The adjustment instead occurred on the
Figure 3: Trends in subnational deficits
expenditure side. As a group, subnational governments
0.6
managed to cut expenditures by 9 percent in real
0.4 terms between 2013 and 2015—5 percentage points
0.2 more than the cuts in revenues.
Percent of GDP
0
0.2
41. The largest cuts, in absolute terms, were in
education. As shown in Figure 5, total spending on this
0.4
sector fell 11 percent in real terms between 2013 and
0.6
2015 (increasing only 6 percent in nominal terms.) This
0.8 is somewhat surprising, given the federal directive to
1
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
increase the salaries of teachers during this period (see
Source: Roskazna. above). If subnational governments were struggling
to achieve the target before the deadline, this would
percent to only 1.8 percent. suggest that education spending would increase
39. How was this possible? It was not due to rather than decrease over this period. It is not possible
improvements on the revenue side. As shown in to precisely measure trends in the education wage bill
Figure 4, aggregate subnational revenues declined, over this period. In the Russian budget classification
in real terms, by 4 percent between 2013 and 2015. system, subnational spending on teachers’ salaries
While CIT revenues increased modestly (3 percent is subsumed in the category ‘transfers to municipal
over their 2013 levels), PIT revenues declined by 5 institutions’. It is instructive, nevertheless, that
percent in real terms. In total, subnational tax revenues spending in this category fell by 7 percent in real terms
(including revenues from property, excise and over the 2013-2015 period, accounting for nearly half
transport taxes) declined 2 percent over the period. of the total decline in spending in the sector. Spending
Aggregate transfers from the federal government 15
As discussed below, the decline in transfers was partially offset by an
declined even more sharply. Dotacii declined by 10 increase in federal transfers to the Federal Medical Insurance Fund
(MIF), which allocates these funds to regional MIFs. This enabled a
percent, subsidii dropped by a remarkable 34 percent, decline in subsidies for health care from regional budgets.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 13
on capital investment also fell dramatically--30 percent their financial support of such facilities.
in real terms-accounting for another 17 percent of 44. The increase in HIF financing was financed
the reduction in total spending. (Cuts in spending on by a federally mandated increase in employers’
direct labor costs and ‘other’ account for most of the contributions to the HIF. As employers, regional
governments had to increase their contributions as
Figure 5: Trends in subnational expenditures
well. Subnational contributions to the HIF increased
3,000,000
over this period—by 9 percent in real terms. But
2,500,000 overall, regional governments presumably gained
more than they lost under the reform. While they were
Transport
2,000,000
required to increase their contributions to the HIF,
Rbs Bns of 2015
Housing, utilities
1,500,000 Education they were no longer required to finance the maternity
Health wards and emergency rooms that had formerly been
1,000,000
Social protection under their purview.
Other
500,000
45. One might expect that spending on social
-
2012 2013 2014 2015
assistance would increase in the face of an economic
Source: Roskazna. slowdown, but that was not the case. Spending on
social assistance remained roughly constant over the
remainder.) period. The explanation may lie partly in the nature
42. Cuts in health care were more modest, falling 4 of social assistance benefits in Russia. As noted
percent in real terms over the period 2013-2015. As earlier, some benefits are not means-tested and are
in education, one might expect that the wage bill in instead allocated on the basis of status; e.g., WWII
regional health care institutions would have risen veterans and labor heroes. Such benefits would
over this period in response to the federal directive not be expected to increase in the face of declining
on salaries. Again, one would be stymied by data incomes. Other benefits are means-tested but in
constraints. As noted earlier, the recurrent costs of ways that are more sensitive to changes in policy
the majority of regional health care institutions are than actual changes in household income. The level
largely financed by the national Health Insurance of pension top-ups, as noted earlier, is based on the
Fund. The majority of subnational spending on difference between an individual’s federal pension
health care takes the form of payments to the HIF on and the official subsistence income for each region.
behalf of those who are not required to contribute If the official subsistence income is not increased (to
directly and payments to specialized medical account for inflation, for example), the level of the
institutions that are not covered by the HIF. Data on pension top-up would not increase either. It should
the wage bill of subnational health care institutions also be emphasized that regional governments have
per se is not available. considerable discretion in designing their own social
assistance programs. As long as federal guidelines are
43. The majority of the cuts fell on facilities that, satisfied, regional governments may cut benefits to
at the outset, had been directly financed by regional fit their own budget constraints, and they may have
governments. Subnational health care spending, responded to the decline in their revenues by doing
net of HIF contributions, fell by 23 percent over the exactly so.
period. Capital spending alone fell by 32 percent. But
parts of these cuts were offset by an expansion in the 46. In addition to the cuts in social spending,
scope of facilities covered by the HIF. Over the period, subnational governments also made substantial
the HIF added maternity wards and emergency rooms reductions in spending in the infrastructure sectors.
to the list, permitting regional governments to reduce Spending on the ‘national economy’ sector (largely
14 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
roads) fell by 5 percent in real terms. In particular, including the above-mentioned Magadanskaya.
capital spending (which accounts for about 20 percent Debt
of total spending in the sector) fell by 15 percent. 48. Subnational deficits, particularly during the first
Spending in the housing and communal services economic crisis (2009) and the more recent nadir of
sector fell even further: 16 percent. Capital spending 2013, have resulted in growing levels of subnational
(which accounts for about 30 percent of spending in debt. As shown in Figure 7, the level of subnational
the sector), fell by 22 percent. Subsidies to companies, debt peaked (in constant terms) in 2014, but has since
which account for 16 percent of spending, fell by 24 stabilized. Subnational debt totaled Rb 2,318 billion
percent. In total, cuts in spending in the infrastructure at the end of 2015. This was equal to 33 percent of
sectors accounted for 41 percent of the total reductions subnational discretionary17 revenues and 2.9 percent
in spending (in real terms) between 2013 and 2015.
Figure 7: Trends in subnational debt
47. While the aggregate subnational deficit in 3,000
2015 was fairly modest (0.2 percent of GDP and 1.8 2,500
Constant Rbs Bns of 2015
of consolidated revenues), there are signs of fiscal
2,000
distress in some jurisdictions. Figure 6 shows the
number of jurisdictions in each of the four deficit-size 1,500
classes, along with the number of jurisdictions with 1,000
surpluses. As shown, 30 regions have modest deficits,
500
in the range of 0-5 percent of revenues. Another 25
have deficits in the range of 5-10 percent of revenues. -
2005 2006 2007 2005 2008 2009 2005 2010 2011 2012 2013 2014 2015
But 22 have deficits of over 10 percent of revenues. Bonds Bank loans Federal loans
Mordovia, Magadanskaya, and Kaliningradskaya top Source: Minfin.
the list, with deficits of 23 percent, 20 percent, and
19 percent, respectively.16 Only nine jurisdictions had of GDP.
budget surpluses in 2015. These include the republic 49. While the aggregate level of subnational debt
cities of Moscow, St. Petersburg, and Sevastopol. As a (33 percent) is not large, relative to revenues, some
group, the rich oil/gas/gold producing regions tend to individual regional governments are highly indebted.
outperform the national averages; Four of the seven Five regional governments have debt-to-revenue
regions had balanced budgets or small surpluses ratios in excess of 100 percent. Over half of them
in 2015, and a fifth had a deficit of only 1 percent have debt-to-revenue ratios in excess of 50 percent.
of revenues. However, two had substantial deficits, As discussed below, the carrying costs of this debt is
Figure 6: Subnational deficits
generally low, but its short-term nature represents a
significant rollover risks in some jurisdictions.
35
30
50. Roughly half of subnational debt (44 percent)
N of Jurisdicitons
25 takes the form of short-term loans from commercial
20 banks.18 Data from the 13 regions, accounting for
15 about 40 percent of total debt (as of January 1, 2016),
10
shows that 45 percent of this debt was due by the
end of 2016, 20 percent by the end of 2017, and 20
5
percent by the end of 2018. Rating agencies consider
0
20%+ 10-20% 5-10% 0-5% SURPLUS much of this debt to be speculative. Of the 20 regional
Deﬁcit as percent of revenues
Source: Roskazna. 17
Discretionary revenues are defined as total own-source revenues
(including shared taxes) plus unconditional grants.
16
However, these regions do not violate the 15 percent deficit 18
These banks are not, strictly speaking, private. Commercial bank
restrictions imposed by the Budget Code because these restrictions lending financing of subnational governments is dominated by two
do not apply to deficits covered by federal loans. state-controlled banks: Sberbank and VTB.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 15
BOX 6: NON-CONTRACTUAL LIABILITIES
The explicit fiscal difficulties of subnational governments are exacerbated by their implicit liabilities. These
liabilities include: (1) public employees’ wage arrears, (2) deferred payables to suppliers of utilities to
government institutions, (3) deferred payables and debt of regional and municipal public enterprises, and (4)
liabilities of joint stock companies in which regional governments possess shares. The scale of these liabilities
cannot be determined with the data at hand. Information on these liabilities is not collected and published
on a regular basis by the federal government or by the regions. It would be worthy, nevertheless, of further
investigation.
governments rated by Fitch since the start of 2016, 54. Despite the growth in the stock of subnational
only four were rated ‘marginally good’ (BBB). Eleven debt, the cost of servicing debt is not a significant
were in the speculative range (BB- to BB+), and five burden to subnational governments. Interest
were rated as highly speculative.19 The City of Moscow, payments on regional government debt consume, on
which was rated in November 2015, was accorded a average, only 1.6 percent of budgetary expenditures.21
marginally good (BBB-) ranking. (For municipalities, the figure is only 0.6 percent.) The
more pressing problem, at least for some jurisdictions,
52. Commercial banks have been increasingly is the debt’s payment structure. Because the majority
reluctant to roll over their existing loans to subnational of commercial debt is short-term, subnational
governments, charging high interest rates if they are governments continue to face a rollover risk. While
willing to roll them over at all. In response, the federal the federal government has (so far) been willing
government has stepped in. Following in the tracks to finance the rollover of commercial debt, it is not
of its response to the 2009 fiscal crisis, the federal clear how long this can continue. The government has
government is now offering to refinance subnational placed a Rb 310 million cap on the volume of loans it
commercial loans with loans of its own. These loans will extend to subnational governments in 2016. Once
generally have a maximum maturity of three years.20 this ceiling is reached, the federal government may
be forced to raise the ceiling or face the prospect of
53. The current interest rate on them is 0.1 percent, subnational defaults.
and with inflation running at 13 percent, the rate is
strongly negative in real terms. Federal loans now
account for one-third of subnational debt.
The five are: Kostroma, Ryazan, Volgoskaya, Mordovia, and Karelia.
19
The exceptions are federal loans provided for special purposes such
20
There are exceptions; In Vologda, for example, debt service costs
21
as constructing the 2018 Football World Cup infrastructure. reached 5 percent of total expenditures in 2014.
16 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
BOX 7: DEBT REGULATIONS
If subnational deficits persist, could borrowing get out of control? At present, subnational borrowing is
controlled by a tight system of regulations. The current Budget Code sets out the regulations on subnational
borrowing. These include three types of debt ceilings.
The first refers to deficits. Budget deficits of regional governments may not exceed 15 percent of annual
revenues. For municipalities, the ceiling is 10 percent. In both cases, the calculation of revenues excludes all
intergovernmental transfers. In the case of municipalities, it also excludes revenues from shared regional taxes.
Even tighter limits are placed on regions that are highly dependent on transfers. For regional governments
that derived more than 40 percent of revenues from transfers during two of the three previous years, the
deficit may not exceed 10 percent of revenues, excluding intergovernmental transfers. For municipalities that
derived more than 50 percent of revenues from transfers, deficits may not exceed 5 percent of revenues
(again, excluding transfers and shared regional taxes).
The second ceiling refers to debt stocks. The Budget Code stipulates that the outstanding debt of a region or
municipality may not exceed 100 percent of its annual revenues, excluding intergovernmental transfers. For
transfer-dependent regions and municipalities, the ceiling is 50 percent.
The third ceiling refers to debt service. The Budget Code stipulates that the debt service of a region or
municipality may not exceed 15 percent of expenditures of the relevant year.
Taken together (or even individually), these ceilings would appear to be quite restrictive. By excluding
intergovernmental transfers (and shared taxes, in the case of municipalities) from the calculation of revenues,
the ceilings severely limit borrowing by jurisdictions that are dependent on these sources. (Technically, a
region that depended entirely on transfers would not be able to borrow at all.)
Recent calculations of the debt-to-revenue ratios of each regional government indicate near-universal
compliance with the Budget Code ceilings. But the ceilings have one loophole: until 2017, they do not apply
to federal refinancing loans. If those loans are included, 18 of Russia’s 85 regions would exceed the ceilings;
12 of the regions subject to the 100 percent ceiling and six of the transfer-dependent regions subject to the
limit of 50 percent.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 17
3 THE PROGNOSIS
55. While subnational governments have, so percent. Unless the ceilings are raised, neither tax is
far, successfully adjusted to the recent economic likely to generate much revenue.
downturn, it is not clear how sustainable this
adjustment is—whether it can endure in a purely 58. Other countries in the region are often
fiscal sense—and what its implications are for the encouraged to increase tariffs on utilities and public
services that subnational governments provide. The transport as a means of generating revenues (or
10 percent (real) cut in spending on education and the cutting subsidies). But Russia has already taken
20 percent cut in capital expenditures (across all five advantage of these opportunities. Unlike in Warsaw
major sectors) suggest that Russia is failing to invest or Bucharest, for example, tariff levels on the subway
in its future. The failure of increasing social assistance systems of Moscow and St. Petersburg are already
spending in the face of falling household incomes close to full operating-cost recovery levels. The same
suggests that some of the costs of adjustment are is true of district heating companies. While there
falling on the poor. may be cost-savings measures in both sectors, the
opportunity to reduce the fiscal burden that transport
SHORT-TERM MEASURES and district heating companies impose on the budgets
Revenues of their owners has apparently already been seized.
56. What can be done? In principle, there are
59. In principle, of course, the federal government
a range of measures on the revenue side that
could help. It could, for example, increase the level
individual jurisdictions could take on their own,
of transfers to subnational governments. This was
within the framework of existing legislation. To start
the federal response to previous crises. But since the
with, regional governments could raise the CIT rate to
federal government now has fiscal problems of its own,
the maximum 17 percent and refrain from granting
this option is unpromising. The federal government
exemptions and tax reductions to individual firms in
could also increase the rate of the personal income
the future. Given the importance of the CIT, this could
have a significant impact on revenues, particularly in tax. As noted earlier, the rate of the PIT is fixed in the
the more industrial and urbanized regions. Regional federal tax code even though all PIT revenues accrue
governments could also accelerate the shift from book to subnational governments. That rate is currently a
value to market value as the basis for assessing the flat 13 percent for most forms of income. Raising taxes
company asset tax. in the middle of a recession is a questionable strategy
from a macroeconomic perspective, however. The
57. In principle, subnational governments could same applies to the other revenue-side measures.
also increase the yields of other taxes. They could, for
example, accelerate the shift to market values as the Expenditures
basis for assessing the land tax, the building tax (the 60. On the expenditure side, subnational
property tax on physical persons), and the corporate governments could continue to pursue what
property tax. But the federal ceilings on the rates appears to be their current strategy—cutting capital
of these taxes are so low22 that the fiscal impact of expenditures and restraining the wage bill.23 This
doing so would be very small. As noted earlier, the is a common adjustment strategy—for both central
maximum rate of the land tax (on agricultural land) and local governments—in much of the region.
is only 0.3 percent, and the maximum rate of the As a short-term measure, it can work well. On the
building tax (on residential buildings) is only 0.1 capital spending side, new starts on capital works
The maximum rate on the corporate property tax is a substantial 2
22
As noted earlier, direct evidence of reductions in the wage bill is not
23
percent. But corporate property is largely assessed on the basis of its available as subnational expenditures in labor-intensive sectors, such
book value, which is typically far below market value. as education, are classified as ‘transfers to municipal institutions’.
can be readily postponed. But suspending ongoing 63. These strategies are only sustainable in the
capital works is more problematic, as half-completed short-term. Eventually, capital spending must be
works can fall into ruin long before funding becomes resumed to permit the expansion or replacement of
available to complete them. Overall, the fiscal impact infrastructure. Wages have to be increased in order to
of cutting capital spending is not likely to be large. This attract and retain qualified staff, and recruitment must
is because capital spending represents only a small be resumed to fill key positions.
proportion of total subnational spending (in Russia,
the proportion in 2015 was about 10 percent). LONG-TERM MEASURES
64. In the longer run, fiscal sustainability will require
61. Cutting the wage bill is likely to have a more fundamental changes aimed at improving
much larger effect, due to the large proportion of public sector efficiency. Experience in other countries
subnational spending that is (presumably) devoted suggests several possible targets. At the most
to salaries. In principal, there are two immediate ways general level, regional governments could undertake
to cut wage spending. The first is by freezing nominal functional reviews to identify activities that could be
wages. This can have a substantial and immediate dropped or privatized. As described in Box 8, such
impact. With the inflation target of 4 percent, which efforts have shown some success (at least at a national
the central bank strives to reach by end 2017, a freeze level) in other countries. Regional governments could
on current nominal wages would reduce the wage also pursue reforms in specific functional areas; e.g.,
bill by a proportionate percent per year in real terms. capital investment selection, construction contract
This could, of course, run afoul of the federal directive administration, or procurement reform.
requiring the salaries of certain professions, such as
teachers and health workers, to equal the prevailing 65. Regions could undertake more targeted
wage in each region. But if regional wages are also methods to restrain their wage bills. Department-
falling, even this obstacle might not exist.24 level functional reviews could help identify redundant
positions that could be eliminated. Regions might also
62. The second technique is to reduce staffing undertake pay and grading reforms. Such exercises are
numbers. Efforts to do so on a large scale can be aimed at adjusting the salaries of individual positions
difficult. In most European countries, confirmed to reflect labor market conditions. It is certainly
civil service employees are typically protected from conceivable that regional governments are paying too
dismissal except for cause (public sector unions also much for some positions while paying too little for
play a role in restraining downsizing). A more palatable others. Pay and grading reforms would allow regional
approach is to freeze new hiring. This can take time governments to increase salaries in occupations that
to have an impact, however, as net reductions in staff have been difficult to fill while constraining (or even
cuts do not occur until existing staff retire. Another reducing) salaries in occupations where regional
approach is voluntary separation—where employees governments are now paying more than the labor
leave in return for financial compensation. But this can market requires.
be expensive, and employees can also raise problems
of adverse selection. Only staff with good prospects of 66. Specific efficiency reforms can be found in
finding alternative employment may take advantage individual sectors. The education sector would appear
of such programs, and they tend to be the most skilled to be a likely candidate. At a first glance, it appears
and hard working employees—the very employees that substantial savings could be achieved through
that subnational governments would like to keep. school network rationalization. As in Eastern European
In the health sector, the direct impact of reducing real salaries
24
countries, Russia has experienced a decline in the
would be limited. As noted earlier, regional governments are directly
responsible only for financing specialized hospitals. The HIF is number of school-age children. In principle, this should
responsible for financing the operating costs of all other health care allow for a reduction in the number of classes and a
facilities. Cost reductions in those facilities would not directly reduce
the premiums that regional governments are required to contribute consequent reduction in the number of teachers. The
to the HIF, although the resulting savings could result in a reduction
in premiums over the long term. available evidence suggests that this opportunity has
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 19
BOX 8: FUNCTIONAL REVIEWS: A MIXED TRACK RECORD
Some of the most ambitious efforts to right-size the public sector take the form of functional reviews. The
scope of functional reviews varies. Some look broadly at the role of the public sector in order to identify
functions that could be abandoned, privatized, or transferred to subordinate levels of government. Functional
reviews also vary in terms of the units of government they cover. Some look at the entire public sector, while
others look at specific ministries or even specific programs to see how existing functions could be performed
more efficiently.
The record of functional reviews is, at best, mixed. Several former socialist countries have used functional
reviews to identify government activities that could best be performed by the private sector. This has led to
the privatization of a wide range of formerly state-owned commercial and industrial enterprises. But efforts to
right-size the residual functions of government—defense and internal security, public education, and health
care—have been less successful.
There are cases of ostensible success. One of the most widely cited is the Canadian comprehensive program
review of 1994/95. The Canadian effort, launched after years of half-starts and in the midst of a fiscal crisis,
required each agency of the federal government to review its own programs to determine which could
be offloaded onto the provinces, the private sector, or abandoned altogether, or—if none of the above—
performed more efficiently. The Canadian effort reportedly resulted in a 19 percent reduction in the federal
workforce (although many positions were merely transferred to the provinces), reduced the number of
ministries from 35 to 23, and eliminated 73 government agencies/boards.
New Zealand’s functional review, while also focusing on paring down the role of the central government,
attempted to increase accountability in the functions that remained. It restructured the government into
departments whose functions could be quantitatively measured. Targets were then specified for each
department and incorporated in performance agreements, whose results were monitored and, if met,
rewarded.
A very extensive set of sector-specific functional reviews has recently been completed in Romania. Eastern
Europe has also seen more modest efforts such as the functional review of the Latvian Ministry of Agriculture.
This identified and evaluated 161 separate functions within the ministry, of which nine were pegged for
privatization, 40 for rationalization, and 12 for transfer to other ministries.
already been seized to some extent. According to the network rationalization may exist but will need to be
World Bank’s recent review of the education sector,25 reviewed carefully.
a large number of small schools have either been
closed or consolidated in recent years, particularly 67. There may also be opportunities for increased
in rural areas where the number of schools has cost-savings in the health care sector. A 2011 report
decreased by almost 25 percent. But many of these by the European Observatory on Health Systems
‘closures’ involved only a reclassification of existing and Policies26 found that the Russian health system
schools. They ceased to be independent legal entities is significantly biased toward expensive inpatient
and became branches of other schools. In physical (hospital) care at the expense of more cost-effective
terms, they continued to exist. As a result, no cost- primary care services. According to the report,
savings were achieved. Thus, further opportunities for hospitalization rates are significantly higher in Russia
World Bank, 2012, The Education System in the Russian Federation,
25
European Observatory on Health Systems and Policies, 2011, Russian
26
Education Brief. Federation Health System Review.
20 Russia: Subnational Governments’ Fiscal Response to the Economic Downturn
than in other countries of the WHO European Region. remarkably sanguine about the fiscal prospects of
The federal government is reportedly taking steps to their respective jurisdictions. Most of them budgeted
close redundant hospitals and expand primary care for small deficits in 2016 but insisted that this merely
services.27 But according to the European Observatory reflects their own conservatism rather than any
report, there is no evidence yet that this policy has serious expectation of a fiscal shortfall. They intend to
been successful. muddle through in the hopes that the economy will
improve or the federal government will come to their
68. Regional governments could reduce spending rescue.
on social assistance, exercising the discretion granted
to them by federal legislation. A logical strategy would 70. Outside experts are more concerned. Staff at
be to improve targeting. As noted earlier, some social one leading debt rating agency argue that subnational
assistance benefits are not means tested at all (e.g., governments have exhausted their budgetary flexibility
benefits to labor heroes). In other cases, targeting and have no more room to adjust. In particular, they
is imprecise. The housing allowance, for example, note that capital spending has been reduced to the
fails to target the poorest of the poor. This is in part bone, that the prospects for increased federal support
because much of it is paid out to households in larger are poor, and that some jurisdictions are therefore
cities (which have higher housing costs) and partly likely to follow Novgorod Oblast into default.
because the amount of the payment is based on the
proportion of household income spent on utilities, 71. The most plausible scenario probably falls
a highly problematic way to identify the poor. To somewhere in between. It is true that subnational
address this problem, a recent (May 10, 2016) World governments have little opportunity to make
Bank draft report on social protection28 recommends adjustments on the revenue side. Within existing
mapping and consolidating programs awarded to federal constraints, they have limited ability to increase
specific categories of population (e.g., labor heroes) the yield of the CIT and virtually no opportunity to
and changing their eligibility criteria so as to focus on increase revenues from the PIT. But they do have
individuals/ households with lower incomes. It cites opportunities to reduce expenditures. This has been
pension top-ups and subsidies for housing and utilities their strategy so far. How far they can go without
as ‘low-hanging fruit’ for such reforms. collateral damage is contingent on how they make the
cuts: this depends on whether they rely largely on cuts
69. Without such reforms, are subnational in the real salaries of front-line service providers and
governments inexorably heading toward a crisis? There capital spending, or whether they focus on measures
appear to be two views about this. The subnational aimed at improving efficiency of individual services.
government officials interviewed for this report were
27
According to the State Statistical Service, the number of district
hospitals in rural areas fell from 2,631 to only 124 between 2005 and
2013. But at the same time, the number of local health clinics fell
from 7,404 to 2,561. As in the case of schools, these closures often
represented only a change in legal status: the facilities ceased to be
independent legal entities and became branches of other health care
facilities. In physical terms, they continued to exist. As a result, no
cost-savings were achieved.
28
Aleksandra Posarac, Zoran Anusic, and Ruslan Yemtsov, May 10,
2016, “Russia SCD: Social Protection”, Draft report.
Russia: Subnational Governments’ Fiscal Response to the Economic Downturn 21
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